Lacker-Evans Clash Pits Japan Risk Against ’70s Inflation

By Craig Torres and Joshua Zumbrun -
Apr 3, 2013

Two Federal Reserve district bank
presidents from opposite sides of the U.S. monetary policy
spectrum debated whether the Fed can sustain record stimulus to
fuel job growth without causing an inflationary surge.

Charles Evans, president of the Chicago Fed, said the U.S.
must avoid the fate of deflation-plagued Japan as he argued for
maintaining record easing. “There’s still work to do,” he said
at yesterday’s forum. Richmond’s Jeffrey Lacker raised the
specter of 1970s-style inflation as he warned against keeping
interest rates low for too long. “I am trying to look around
the bend, trying to anticipate what could go wrong,” he said.

Lacker dissented at every meeting of the Federal Open
Market Committee last year as the Fed pledged to keep interest
rates at a record low and embarked on a third round of large
scale bond purchases to spur the economy. By contrast, Evans
started in early 2011 calling for a new policy approach tying
changes in the main interest rate closer to the Fed’s mandate to
achieve stable prices and full employment, an approach the Fed
adopted. Evans votes on policy this year, while Lacker doesn’t.

The two policy makers, speaking in Richmond, Virginia,
debated the merits of Chairman Ben S. Bernanke’s strategy to
heal a job market still bruised by the worst recession since the
Great Depression. Bernanke said last month the Fed will continue
a stimulus program of bond buying until achieving
“substantial” employment gains, including in payrolls, wages
and jobless claims.

Jobless Rate

The U.S. economy is in its fourth year of expansion after
emerging from recession in June 2009. Consumer prices rose just
1.3 percent in February from a year earlier, according to an
inflation measure favored by the Fed, below the central bank’s 2
percent target. Meanwhile, growth has been too weak to generate
jobs for millions of fired workers. The unemployment rate stood
at 7.7 percent in February.

The yield on the benchmark 10-year Treasury note fell to a
two-month low today, showing there’s little concern among
investors that inflation is a threat. The note yielded 1.82
percent at 12:36 p.m. in New York, down from 1.86 percent
yesterday.

The prospect of further Fed easing has helped push U.S.
stock indexes to new highs. After hitting a record 1,570.25 in
New York yesterday, the Standard & Poor’s 500 Index fell 0.7
percent to 1,560.08 at 12:36 p.m. following a worse-than-
expected report on employment from the ADP Research Institute.

Companies boosted employment by 158,000 in March, down from
237,000 in February, according to the Roseland, New Jersey-based
firm.

Below Objective

The FOMC “thinks that at the end of 2014 we’re still going
to be below the inflation objective and unemployment is still
going to be above 5.5 percent” Evans said, referring to the
central bank’s dual mandate for stable prices and maximum
employment, which he said he estimates at 5.5 percent.

“In about two years, we are still going to be missing” on
the employment objective, Evans, 55, said at Virginia
Commonwealth University.

While the central bank has control over inflation, it has
only a limited ability to influence the unemployment rate,
Lacker said.

The Richmond Fed president called monetary policy in the
1970s “a disaster” because Fed officials were unable to reduce
inflation for fear of increasing unemployment.

“I do not expect inflation to rise significantly in the
next year or two,” Lacker said. “But I will say that given the
policies we have adopted, I see upside risks.”

Near Zero

Evans in March 2012 proposed holding the federal funds rate
near zero until unemployment fell below a 7 percent
“threshold,” or until inflation was forecast to exceed 3
percent “over the medium term.”

The FOMC in December adopted a version of Evans’ proposal,
pledging to keep the main interest rate near zero so long as the
unemployment rate remains above 6.5 percent and inflation isn’t
forecast to accelerate above 2.5 percent one to two years in the
future. Lacker, 57, cast his last dissenting vote of 2012
against that decision.

“I am much more optimistic that this is in fact the year
that the economy takes off and doesn’t stall out in the second
half like happened in 2010, 2011, and 2012,” Evans said to
reporters after the debate. Even if unemployment hit the Fed’s
6.5 percent threshold the central bank could hold the benchmark
lending rate low if “inflation was not a problem.”

Benchmark Rate

The Fed cut its benchmark lending rate to a range of zero
to 0.25 percent in December of 2008, compelling Bernanke to use
the size and composition of the central bank’s balance sheet as
a new tool to stimulate the economy.

Central bankers engaged in three rounds of quantitative
easing, including a decision last September to expand the
balance sheet further with $40 billion a month in mortgage-
backed securities purchases.

In December, the FOMC expanded its third round of so-called
quantitative easing, adding $45 billion in Treasury purchases
for a total of $85 billion in monthly buying.